Volatility Index

Developed by J. Welles Wilder, the Volatility Index is a trend-following system used to measure true range over time. The interpretation is if volatility is high, the range is expanding and the opposite holds.

Study Type: Stand-alone

Description

The only difference between the Volatility Index and the Average True Range is the VI uses an exponential moving average vs. a simple moving average in the calculation.

Welles Wilder developed Average True Range to create a tool for a precise and realistic calculation of market's price activity. This value is considered when calculating the directional movement of a market. Mr. Wilder defined the True Range to be the greatest for the following periods:

• The distance from today's high to today's low.
• The distance from yesterday's close to today's high.
• The distance from yesterday's close to today's low.

True Range measures market volatility and is an integral part of indicators such as ADX (Average Directional Movement) or ADXR (Average Directional Movement Rating), and several others, to identify the directional movement of a market. The ATR is the basic unit of measurement for Wilder's Volatility System.

The Average True Range indicator identifies periods of high and low volatility in a market. High volatility describes a market with ongoing price fluctuation, whereas low volatility is used to label a market with little price activity. Measuring market volatility can help in identifying buy and sell signals and, additionally, risk potential. Markets with high price fluctuation offer more risk/reward potential, because prices rise and fall in a short time, giving the investor the opportunity to buy or sell at, supposedly, the right moment.

When a market becomes increasingly volatile, the ATR tends to peak rising in value, and during periods of little volatility, the ATR bottoms out decreasing in value. A market will usually keep the direction of the initial price move, though this is certainly not a rule. Analysts, therefore, tend to use Average True Range to measure market volatility and other technical indicators to help identify market direction.

Parameters

Period: (14) - Number of periods to use for the Exponential Moving Average